Safety Wins Over Returns in London

Global Investors Focus on 'Wealth Preservation, Not Growth,' Think Long Term

By

Anita Likus Special to the WSJ

Updated Aug. 21, 2012 7:08 p.m. ET

LONDON—Global financial and political turmoil has caused an unusual situation in London's office market: Investor demand for buildings continues to rise even as potential income from the properties weakens.

The disconnect is driven by international investors looking to escape the volatile euro zone and the tumultuous Mideast while viewing London commercial property as a haven, real-estate executives say.

ENLARGE

About £8.2 billion ($12.9 billion) of London office property already has changed hands this year, according to property adviser BNP Paribas Real Estate. It said London office investment for all of 2011 was £10.7 billion. The bank estimates that more than 70% of buyers come from overseas, led by institutional investors from Asia and the Middle East along with affluent individuals from Latin America and Canada.

Alan Carter,
analyst at Investec, cautioned that investors are buying "pretty dry assets, where the only likely enhancement to returns may come from rental values edging higher…in the next round of rent reviews, but it really is likely to be pretty pedestrian."

The U.K.'s economy is in the doldrums, the global financial sector, which makes the City of London its home, is pulling back and leasing rates are stagnant. But investors believe London commercial real estate will at least retain its value, even if it doesn't produce increased income in the immediate future.

"Investors focus on wealth preservation, as opposed to growth, and think long term when they buy offices in London," said
Andrew Cruickshank,
BNP Paribas's international investment director. "I speak with many Middle Eastern investors who are absolutely terrified about the Iran situation, and London is a second home for them," he said.

As the euro zone lurches from crisis to crisis, London looks resilient. At the same time, the market is unlikely to become a source of rising income anytime soon. Prime rents across Central London offices were unchanged in the second quarter from the prior quarter, at £55 a square foot, while offices in pricey West End also were unchanged, at £92.50 a square foot, according to data from data from property-services company CBRE.

Newly rented space in the quarter rose 6% to 2.4 million square feet from the first quarter, but this still is short of the 10-year average of 2.9 million square feet, CBRE says.

Meanwhile, available space for rent in Central London increased 4% to 17.2 million square feet as developers started marketing office space on buildings yet to be completed, CBRE says. In London's financial district, CBRE reported 13 empty buildings of 100,000 square feet or more currently available for rent, up from 11 such properties in the first quarter.

More supply is coming. Property companies are planning to bring 1.9 million square feet of new space onto the market in 2013 and 2.6 million square feet in 2014. Only a modest proportion of this space has been preleased.

Land Securities
PLC's 20 Fenchurch St. development, a new skyscraper at the heart of London's finance hub that will put 600,000 square feet of office space onto the market in 2014, is 19% preleased or under negotiation. At
British Land
Co.
PLC's Leadenhall Building, dubbed the Cheesegrater because of its shape and which will put 576,200 square feet of space onto the London City office market, less than half of the space is committed or under negotiation. Both companies declined to comment.

Yet while the renting scenario is bleak, sales prices for buildings have returned almost to prerecession levels. Based on an index compiled by BNP Paribas, values for office buildings declined 43% from their 2007 peak to 2009 trough. But they have since risen 40%, according to the index, which tracks 11,000 properties.

For buyers, it all means slim returns for new office landlords. BNP Paribas estimates that yields on offices recently acquired in the City of London are about 5% and are trending about 4% in the West End. Those yields are little higher than at the peak of the market before the financial bust, but they are lower than in August 2009, when yields averaged 6.5% in the City of London and 5.75% in West End.

As foreign buyers pile in, U.K. real-estate investment trusts are starting to sell assets. They have sold 17% of the £8.2 billion of offices sold this year. "While the strength of the Central London office investment market shows no signs of abating, U.K. REITs should be selling assets, which don't have growth prospects given the weakening rental environment and expensive management structures," said Investec analyst
John Cahill.

As an example of the selloff, Mr. Carter at Investec points to Land Securities, the U.K.'s largest REIT, for selling Arundel Great Court offices for £234 million to Waterway PCP Properties Ltd. "The property is much better suited for a residential development than offices," Mr. Cahill said, while Land Securities specializes in office properties.

And
Hammerson
PLC, one of the U.K.'s largest listed property companies, has started to sell off its £630 million office portfolio, seeing the future in more specialized holdings of shopping centers and luxury outlets. The company already sold the majority of its offices to real-estate manager and developer
Brookfield Office Properties
for £518 million and said it would start marketing its Stockley House offices in September along with the 30% stake of its Gresham Street office. The entire Gresham Street building could sell for £200 million, according to a person close to the sale.

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